Oil Crude Prices Go Negative

Many questions have surfaced about the historic price move of the WTI futures on April 20th and 21st, 2020. To fully appreciate this event, it is important to remember that just a few months earlier oil prices were near the highs of their 12-month trading range, in large part because the world was focused on geopolitical unrest. Prices peaked in early January, with WTI momentarily trading above $65, after Iranian General Soleimani was assassinated. During the following months, as tensions eased and fundamentals eroded, prices methodically worked lower until on Friday, April 17th they closed at $18.27. That set the stage for the final two trading days of the May WTI futures contract. Here is our summary of the price drivers responsible for the price drop leading up to that Friday and the precipitous collapse that followed:

On Monday, April 20th, the May WTI futures contract opened down $0.54, trading $17.73. Then it proceeded to trade lower the rest of the day. By 11 AM the price had fallen to $10 and at 1 PM it was $0.01. During the next 15 minutes, prices went negative for the first time in oil’s history and in the final 15 minutes had a range of -$4.60 to -$40.32, with a settlement price of -$37.63. What transpired during the final two trading days of the May WTI futures contract was unprecedented. Here is our summary of the price drivers responsible for the movement:

1)     NOT AN OVERNIGHT STORY The Coronavirus first surfaced in January. Fear of the disease, and its impact on oil demand, quickly escalated.  Air travel declined, and with it jet fuel demand dropped. Then gasoline demand fell as governments across the globe ordered citizens to “shelter in place”.  Compounding the problem in March, Russia did not agree to a joint production cut proposed by Saudi Arabia. Saudi Arabia responded by maximizing its production, which began a price war that pushed oil prices below $30. Currently, US refinery runs are now down -25%.  Trafigura, an international marketer of oil and refined products, estimates that global crude oil demand is down -35%, approximately 35MmBpd. When demand drops, oil backs up because midstream and downstream purchasers have less need or ability to buy products.

2)     STORAGE SQUEEZE As demand for crude suddenly dropped, excess barrels of crude oil and refined products began piling up and now need to be stored.  Available storage is limited and has been contracted out many weeks prior to Monday’s move in spot WTI. In their March report, The IEA stated that OECD Industry stocks totaled 2,930 MmBbls and covered 63 days of demand. In July 2016, storage peaked at 3,127MmBbls or ~200 MmBls above current storage levels. While there are other facilities that may be used as improvised storage, i.e. waterborne storage, without production cuts excess capacity is weeks away from filling storage.

3)     NYMEX PHYSICAL DELIVERY The NYMEX futures contract, which is the underlying price for swaps, requires position holders of contracts at settlement to physically deliver or receive oil. Normally, financial traders will be flat at settlement, by accumulating matching long and short positions. During the final two days of the May contract, many financial traders were caught with net long positions. Interactive Brokers, a clearinghouse on the Exchange, admits to an $88MM dollar loss in cleaning up client liquidations and believes a total of $500MM in losses took place.

4)     USO ETF An ETF is an Exchange Traded Fund. The USO ETF is a passive investor in Crude Oil. Its holdings are largely comprised of long NYMEX futures contracts.  What we now know is that as of Monday’s close USO was reported to be long 80% June futures and 20% July futures. Then on Tuesday it was reported to be long 40% June futures, 55% July futures, and 5% August futures. This implies that on Tuesday USO sold 40% of its June position and rolled most of that to July and the balance to August contracts. We don’t know this, but if USO had been long May futures Monday morning, they would have been running out of time to liquidate these positions. It could have been that on Monday they sold their May contracts and bought June contracts, allowing them to maintain long positions in oil. If USO wasn't active on Monday, it was another entity(s) with a similar problem.

5)     THE GREATER IMPACT OF USO As of the close on Monday, the USO represented ~25% of the Open Interest in the June Futures contract. It was probably ordered by the CME to reduce their NYMEX June WTI position, which would explain the restructured position on Tuesday’s close. The CME (parent of NYMEX) has a major problem; the integrity of the Crude Oil contract could be irreparably harmed if this ETF continues to disrupt the market. The concentration of Open Interest by a non-commercial entity is a threat to the Exchange, futures traders and all commercial interests who rely upon pricing that fairly represents market fundamentals.

6)     ALGOs While the long-term impact of algorithmic trading nets to zero, they can disrupt the market in the short-term. It often increases volatility when, as in this case, they sell in front of longs who need to exit, exaggerating the move down.

As disruptive as the negative pricing in oil was on Monday, Tuesday’s price declines were more significant to Producers. On Monday, price declines were largely limited to the spot contract. On Tuesday, all tenors declined significantly. This is the market telling us that it believes the current storage issues will not be resolved quickly.  

Today, oil prices are staging a recovery, encouraged by (a) an OPEC+ conference call yesterday (no action taken), (b) a President Trump tweet warning the Iranians of US Naval action in response to harassment, (c) passage of an additional $484B stimulus package and (d) general market exhaustion from the selling that took place over the past two sessions.